Hurricane Catastrophe Modeling

What is Catastrophe Modeling?Catastrophe modeling is a risk management tool used by insurance companies, businesses, and regulators to assess the potential losses caused by a catastrophic event. Catastrophe models are available for a wide range of risks and include both natural hazards (e.g., hurricane, earthquake, flood, etc.) as well as those of human origin (e.g., cyber attacks, terrorism, etc.). Given South Carolina's geographic location and history, hurricane models receive more focus than models for other types of perils. That said, much of the following discussion regarding hurricane models also applies to other types of models.

Hurricane models combine historical disaster information with current demographic, building, scientific, and financial data to determine the potential cost of hurricanes for a specified geographic are. The skills of many experts including meteorologists, seismologists, geologists, structural engineers, mathematicians, actuaries, and others are used in the development and analysis of the models. Once a model has been constructed, a corresponding computer program is used to access it.

It is important to note that hurricane models do not predict the number of hurricanes that will occur in a given year. Rather, they estimate the average potential impact of hurricanes over a longer period of time. A simpler way to understand this difference is the idea of flipping a coin. Even though the coin is expected to be heads half of the time, that does not mean every other flip will be heads. In the same way, hurricane models estimate long-term average impacts as opposed to one year's actual activity.

How do Insurance Companies use Hurricane Models?An insurance company inputs data about its policies in the catastrophe modeling software. This includes information about the locations of insured properties, physical characteristics of insured structures, and the insurance coverages applicable to the insured properties. The model then estimates the average annual losses to the insurance company. This output can then be used by the company to calculate its rates and the amount of money it should have on hand to pay claims. In the event of a hurricane, an insurance company may also rely on catastrophe modeling to estimate claims resulting from that particular storm.

Catastrophe Modeling PanelIn 2012, the Department assembled a panel consisting of an actuary, a meteorologist, and a structural engineer to review the major hurricane models used to develop insurance rates in South Carolina. Each panel member had considerable experience reviewing natural hazard catastrophe models and was a member of the Professional Team selected to advise Florida's Commission on Hurricane Loss Projection Methodology. The panel reviewed models from AIR Worldwide (AIR), Applied Research Associates (ARA), CoreLogic (formerly EQECAT), and Risk Management Solutions (RMS).

In October 2013, the Department received the panel's final report and held a public hearing consisting of presentations from Department staff, an independent actuary, and a member of the panel as well as comments from the public and interested parties. In December 2013, Order 2013-05 was issued to summarize the findings found in the panel's report and set forth additional actions to be completed. The Department issued Bulletin 2014-03 in March 2014 to provide further guidance to insurance companies incorporating hurricane models in their rate calculations.

Department Hurricane Model ReviewBeginning in 2015, the Department began reviewing new hurricane model versions internally to determine their appropriateness for use in ratemaking. This process is largely based upon the findings and recommendations of the Catastrophe Model Panel and includes an examination of changes to the model as well as rate impacts. Once a new model is approved for use in South Carolina, anticipated expiration dates are set for prior versions. A table displaying the list of currently approved hurricane models can be found here.

State Hurricane Model Feasibility Report The Competitive Insurance Act of 2014 required that the Department provide a report on the feasibility of creating of state hurricane model to certain committees of the General Assembly by January 1, 2015. To fulfill this requirement, the Department employed an actuary and two finance professors from the University of South Carolina's Moore School of Business. Their report recommended that South Carolina not pursue the development of a state specific public hurricane model because the costs of producing and maintaining the model appeared to outweigh the potential benefits.